Should You Convert to a Roth IRA
It is possible and sometimes desirable to convert a traditional IRA to a Roth IRA. With a Roth IRA, you pay no taxes on distributions that fall within the guidelines.
The process is not simple, but our Investment Specialists can walk you through the steps. Because there are major tax implications involved, you should check with a tax professional before taking any action.
New Rules, Tax Breaks and Other Roth IRA Conversion Considerations
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Now you’re eligible regardless of your income
Beginning this year, the $100,000 eligibility income cap that previously applied to individuals who converted a Traditional IRA to a Roth IRA has been lifted and investors will be free to implement a conversion regardless of income level. If you have not considered a Roth conversion in the past because your income level was too high to be eligible, you can now take advantage of it.
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In 2010 you can choose how to pay your conversion taxes
When you convert your Traditional IRA to a Roth IRA, the converted amount will be taxable at your normal income tax rate. You should consult with a tax advisor on your particular situation, but generally, the amount that is subject to taxation includes the deductible contributions you made, rollovers from qualified plans, and earnings on those amounts. However – for 2010 only – you have a choice of whether to pay all taxes due this year at one time, or to spread them over two years. If you choose to pay taxes over the two-year period, half the conversion amount will be taxed in 2011, and the remaining half will be taxed in 2012.
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Consider your expected future tax rate
Your current and future tax bracket has an impact on the long-term benefit of a Roth conversion. As a rule, if you expect that your tax bracket will be significantly lower in retirement, converting to a Roth IRA now may not be beneficial. That’s because you’ll likely end up paying more in taxes and penalties today than you would pay in retirement with your Traditional IRA. On the other hand, an expected higher federal income tax bracket in retirement would generally make it favorable to convert to a Roth IRA now.
Also keep in mind that, although subject to change by Congress, higher federal income tax rates that were in force before 2001 are set to spring back into effect beginning in 2011. Depending on your individual tax situation, this could provide more reason to implement a Roth conversion in 2010.
10% |
15% |
15% |
15% |
25% |
28% |
28% |
31% |
33% |
35% |
35% |
39.6% |
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There are many good reasons to convert some or all of your traditional IRA assets to a Roth IRA, but it is not for everyone. Here are some things to consider:
Advantages
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Conversion may make sense if you are a long way from retirement. You can't predict the tax rates or circumstances in the future, so it may make sense to prepare for the worst (higher tax rates) during your retirement.
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You may also consider a conversion if your IRA assets haven't grown significantly and the tax on their growth would be minimal.
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If you are certain you will be in the same or higher tax bracket after retirement, it might be easier to pay the taxes while you are still working.
Disadvantages
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You may not want to convert traditional IRAs that have significant deductible contributions and earnings.
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If you believe you will be in a lower tax bracket during retirement, you will probably want to consider paying taxes then, rather than paying higher taxes now that would be due on conversion.
For more help in understanding the effect of a conversion, visit the Roth IRA Conversion Analyzer.
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Next Steps
Choosing between a traditional or Roth IRA?
Questions? Specialists are available 24 hours a day at 1-800-359-3379.
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